The IMF recently projected India to be the fastest growing economy in 2016. FDI inflows put India in the top spot amongst all economies. The World Bank feted India for its efforts to improve the ease of doing business. To add some flavour, growth projections have been lowered, exports have been falling for nearly 10 months and IIP has been contracting while NPAs which have risen steadily with no signs of decline.
Understanding the bewildering and contradictory sets of data would then tell us what to do with the stalled GST reform process: ditch it for the time being.
That India is the fastest growing economy should not really excite us as both the size of our economy and the incomes per person are far lower than many countries.Lifting the lid on the ‘one bright spot in a gloomy world economy’ theory being peddled by some policy mandarins is the sombre reality that this growth shows no signs of remaining stable except in a few sectors. Thus we must further ask: where exactly is this growth coming from?
Even the sectors which are most likely to expand first during an upward turn in growth such as Real Estate and Construction show few signs of doing so. This is primarily because bank lending to such activities are largely constrained by the proliferation of Non Performing Assets on the balance sheets of these banks. When credit given out does not return, banks become reluctant to issue fresh loans.
But then what explains the ‘phenomenal’ interest in India and the high amount of FDI inflows? Well, no other economy offers as high returns on investment as promised by India. Traditionally, high return investments went hand in hand with more employment and stable growth in output. But financial sector growth has severed ties between the two because today, financial instruments can generate high returns without bridging the capital needs of industry or agriculture. Thus FDI is largely flowing into low employment potential sectors such as light manufacturing and services. Further, much of this is routed via Mauritius and thus causes significant loss of potential tax revenue.
In a country like India where one doesn’t need a Piketty to tell us that inequality is already too high, thanks to Nehruvian policies which privileged a highly capital-intensive and skill intensive sector (even today only 2% of the population is skilled according to most estimates) this FDI obsession would spell disaster. Again growth in a few sectors benefitting a select few would not be a problem if manufacturing and agriculture growth was high. Barring a few states, agriculture growth has been measly, on the back of two straight years of drought which is further accompanied by falling commodity prices. With a leaky and ineffective price support system, rural India is thus facing falling incomes and bracing for a spike in inflation due to the drought. One can already see the tightening of expenditure from lower tractor and motorbike sales across rural India.
Manufacturing on the other hand, is unlikely to recover unless banks undertake fresh lending which requires significant capital infusion from the central Government. As the Government’s own economic survey noted last year, just 10% of the number of stalled projects account for more than 50% of the total value of stalled project. It has only been a couple of months since the RBI cracked down on defaulters but this flies in face of the political support much of the defaulters enjoy.
However the scenario is far from bleak. The Government can start by spending the money already collected under various cesses for improving social and physical infrastructure which is currently lying unspent.This currently shows up as revenue for the Government, but by law has to be spent for the specific purposes for which they were collected. Its second objective must be to recapitalise banks.
When NPAs are hovering around lakhs of crores, infusing 20-25 thousand Crores under the Indradhanush programme is unlikely to make a dent in the problem. Refusing to put more money into banks would only lower GDP growth. This must take priority, even at the cost of postponing the fiscal deficit target for the year, as short term sacrifice is likely to yield large benefits due to higher lending activity by banks which will boost GDP growth.
To not do so is to persist with the contraction in manufacturing which would lower GDP growth and thus keep the deficit to GDP ratio too high. As far as agriculture is concerned, the focus must be on insuring incomes for farmers and boosting drought-proof technology. Revisiting the opposition to GM crops might help as even field trials largely certified by eminent scientists have been held up by NGO protests. Fully shifting subsidies to cash transfers would reduce leakages, alongside income insurance schemes to protect consumption expenditure of the largely low income rural Indian population.
All of this requires significant political capital. And they cater to the real economy rather than the financial sector. But most crucially, none of these require legislative action via a rambunctious Parliament. The GST bill (if it does get passed after significant compromises and much animosity) will not address any of these key issues but would instead subject the economy to an acute dose of high inflation as taxes in the service sector go up from 14% to a likely 18%.
It would further set the stage for centre-state disputes on a daily basis within the GST council which consists of the centre and states. None of the NDA’s adversaries are in a mood to allow parliament to function smoothly, let alone the GST council. The global and domestic slowdown provides an incredible opportunity for Prime Minister Modi to seize the narrative by making a wise choice on where to expend his political capital- on non-legislative actions that carry the day.